When advising our clients about the most efficient way to withdraw money from their business, we generally outline the three main ways of doing this as being paying themselves a salary, paying themselves Dividends or taking a Director’s Loan from the company. Most people understand the operation of Dividends and Salary as these are fairly straightforward for tax purposes. For many clients, particularly those who have recently incorporated from a sole trader or partnership, the Director’s Loan can be a bit more confusing.
The Basics of the Director’s Loan Account
When you become incorporated, your business becomes a separate legal entity. This means that withdrawing money from the business which is not classified as a salary or dividend takes on the legal form of the business lending you money although the Director’s Loan Account can work both ways (you can loan the business money too).
When you first become incorporated the chances are high that you’ll have a large credit balance within your Director’s loan account, i.e. the business will owe you money. This is because we will have introduced as many assets as we reasonably can which relate to your business, for example computers, office equipment and other business related assets. This means that you’re likely to have a lot of initial leeway with your Director’s Loan account allowing you to withdraw cash from the company.
You can withdraw money from your director’s loan account with no tax implications until the account is overdrawn by £10,000 (As of April 2014). It’s generally not advisable to withdraw cash beyond this point as this introduces a number of further tax considerations.
After £10,000 is overdrawn, HMRC views the Director’s account as a beneficial loan to you and will begin to charge interest. If the loan is not paid back within 9 months after your year end, the business will incur a 25% charge on the amount of this loan to your Corporation tax (E.g. a loan of £10,000 would incur a £2,500 Corporation Tax charge). This can be recovered later, but there’s a long delay in recovering this. On your personal tax return, this will also have to be reported as a personal loan and you will be charged for this “benefit” at the interest rate which HMRC believe you would have been charged by a bank to take out a similar loan.
Other implications of the Director’s Loan
The final thing to consider with a Director’s Loan account is that it is treated as a business asset. This means that should your business ever go into liquidation the liquidator will be obligated to look at whether the money should be pursued and in the worst case scenario if there are creditors outstanding in your business, you may have to repay the full amount of the outstanding Director’s Loan to the business.